Risk is present when future events occur with measurable probability. Uncertainty is present when the likelihood of future events is indefinite or incalculable. Risk can be quantified either on the basis of prior knowledge or empirical observation. Investors can make arrangements to protect themselves against undesired risks, in effect converting risk into certainty. In other words, risk can be measured, avoided, managed, mitigated and/or transferred to another party. By contrast, uncertainty is not measurable, thus cannot be quantified or mitigated through other techniques.
Uncertainty occurs in circumstances that cannot be analyzed or observed because they are not known, are unique or are too infrequent. Indeed, uncertainty is what is left over after we think we’ve thought of everything. (Hart, 2011) In this article it states that unfortunately uncertainty cannot be eliminated altogether so it would be very wise for investors and portfolio managers to figure out a way to channel and manage it. It also states long-term results that would normally turn out positive for the investor are not normally achieved without risk taking.
Before the market crash, investors thought that having a diversified portfolio would keep them from losing a bundle; however, recent years have proven that just having a diversified portfolio isn’t enough. Although uncertainty can be viewed as the source of economic profit, there are still some steps that we are investors can take to protect our investments and manage our risk: * We can avoid it altogether by either disposing of an asset or not buying it at all. We can retain it by knowingly accepting the exposure with the expectation that we will earn a commensurate return. * We can reduce it through thoughtful diversification strategies. * We can transfer it with portfolio hedging techniques. (Hart, 2011) Thus it is clear then that though both ‘risk and uncertainty’ talk about future losses or hazards, while risk can be quantified and measured; there is no known way of ascertaining uncertainty. Risk is thus closer to probability where you know what the chances of an outcome are.
In gambling for example, if you are taking a risk on a particular number in a game of roulette, you know that the probability of that number finally appearing is 1/29 or the number being present in the game, while uncertainty is reflected when you are not sure of the outcome as in the case of putting money on a horse in a horse race. Risk and Uncertainty are concepts that talk about expectations in future, but whereas you can minimize risk by taking health policies to face an uncertain future, you cannot remove uncertainty from life altogether.
When airplanes were introduced, many people were afraid of flying saying it was very risky, and indeed they were right. But with technological advances, the risk factor has been greatly minimized, though there is still uncertainty which is beyond human control. When you are uncertain, you are not sure of what is going to happen next. When you take precautions against a disease, you are reducing the risk of catching it. Thus it becomes clear that risk is when you know that hazard is there, but its occurrence has a very low probability, but uncertainty is when you know nothing about the outcome. (Olivia, 2011)
Hart, K. (2011). Managing Risks and Accepting Uncertainty. Pugent Sound Business Journal, 1-2. Olivia. (2011). Difference Between Risk and Uncertainty. Difference Between.com, 1-3.